as of December 31, 2022
Global markets moved higher for most of the quarter as signs emerged that inflation may have peaked. However, some of the quarter’s gains were given back in December as fears of an economic slowdown and further Federal Reserve tightening weakened sentiment. The drawdown in stocks and bonds last year appears to be a reasonable response to the Federal Reserve’s (‘Fed’) tightening cycle and the resulting uncertainty for economic growth. The decline in equities (stocks) can be explained by the rise in interest rates putting downward pressure on valuations. The outlook for inflation and its impact on Fed policy likely will remain the key driver of markets’ direction in 2023.
Encouragingly, inflationary pressures continue to appear to be easing. A warmer than usual winter in Europe has eased energy supply and price concerns overseas. Energy prices in the US are also off of their peak levels, which should lead the headline inflation rate lower over time. The gradual easing of supply chain issues and weaker demand could also slow core inflation. Shelter inflation is also showing signs of a potential peak. One concern for the inflation outlook is the labor market, which remains strong. Another concern is that the re-opening of China’s economy could drive increased demand, particularly for commodities. US GDP grew in the third quarter after modest declines in the first half of the year. However, the tightening of financial conditions is only just beginning to be felt. The drag likely will intensify in 2023, increasing the risk of at least a mild recession.
Global equities posted gains during Q4, with the MSCI ACWI index rising 9.8%. The index finished 2022 down 18.4%.The S&P 500 gained 7.6% during the quarter, and finished the year down 18.1%. International developed stocks gained 17.3% in Q4, ending the year with a 14.5% decline. Despite the strength of the dollar in 2022, international developed stocks outperformed US stocks. Emerging market equities rose 9.7% in Q4, finishing 2022 with a 20.1% decline.
Within fixed income (bonds), the Bloomberg Aggregate index gained 1.9% during the quarter and finished down 13.0% for the year. Treasuries gained 0.7%, lagging corporate bonds which gained 3.6%. The yield curve shifted higher at the short end of the curve, but otherwise saw modest changes during the quarter.
Global REITs gained roughly 7% during Q4, lagging broader equity markets. Infrastructure stocks gained 9% during the quarter, in line with broader equity markets. Commodities posted modest gains during the quarter as economic activity slowed, but returns remained positive for 2022.
A mild recession that reduces inflation could prove supportive of both stock and bond markets. The prospect of the Fed halting rate increases and a fall in longer-term interest rates could more than offset the negative impact of weak earnings for equities in a mild recession. The biggest downside risk we see for balanced portfolios is if inflation remains sticky even as the economy slows. This could require a more forceful Fed response and a deeper recession. This likely would result in continued weakness in stocks and bonds.
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